By the ETF Research Team at Direxion.

Recession or no? What do the numbers say?

With an increase in chatter about the next recession lurking right around the corner, it is notable that the Manufacturing Purchasing Managers’ Index (PMI) slipped into contraction territory to 49.1 in August after expanding for 35 months.

However, the Non-Manufacturing PMI stands at 56.4 and has now expanded for 115 months and firmly beat survey expectations. Just as commuters around the globe are reminded to mind the gap when entering and exiting trains, investors should stay attuned to the gap between Manufacturing and Non-Manufacturing PMIs.

Mind the manufacturing gap

The difference between the two PMIs stands at 7.3; however, a gap greater than this occurred in 2015 and 2016 when Manufacturing PMI fell below 50 for five straight months. Then, the slowdown in manufacturing was driven by weakness in emerging markets that drove down the price of oil and other commodities along with a rise in the US dollar.

This confluence of events ultimately led to a decrease in capital spending among oil and related industries, such as metals, mining, and agricultural machinery. This weakness did not trickle into the broader economy, which grew firmly for much of that time period as Non-Manufacturing PMI remained firmly above 50 during that time.

MANUFACTURING & NON-MANUFACTURING DATA HAS DIVERGED

Source: Direxion.

New orders at a seven-year low. Does that matter?

More concerning this time may be the drop in new manufacturing orders, which fell to a seven-year low. Seeing new orders relative to inventories declining is a troubling sign as it means respondents see inventories building at a greater rate than new orders are coming in.

During the 2015 to 2016 period when manufacturing contracted, new orders relative to inventories actually remained positive as the slowdown was coming primarily from the oil patch. The period prior to the Global Financial Crisis (GFC) was reflective of a broad and significant slowdown with new orders dropping and inventories climbing.

Today’s tariff-related trade issues could also be broad and have wide impact on business sentiment; although most are not anticipating an upcoming recession, should there be one, it’s not expected to be anywhere near the depth of the GFC.

With that being said, we advocate that investors should stay attuned to future developments in manufacturing data to see if August was a blip or a sign of something deeper. Investors should also remember that manufacturing is an extremely small part of the US economy representing around 11% of overall GDP and that services sectors play a greater role in our overall economic growth.

MANUFACTURING NEW ORDERS RELATIVE TO INVENTORIES COLLAPSED IN AUGUST

Source: Direxion.

Uncertainty is the only certainty

The direction of travel for economic growth increasingly relies on the intersection of tariffs and geopolitical question marks, such as Brexit, contributing to slowing global output and how accommodative monetary policy needs to be in order to address this.

We are entering an increasingly uncertain phase as the decline in business sentiment could spill over into consumption. Recently, Federal Reserve Bank of New York President Williams noted that the consumer is carrying much of the weight going forward, alluding to the need for the consumers to remain resilient in order to stave off a recession.

Unfortunately, the University of Michigan Consumer Sentiment Index saw its biggest drop since 2012. However, retail sales increased in the most recent month, muddying the picture even further as consumers continue to spend even if they feel less good about doing so.

While the US equity markets recently broke out of the relatively narrow trading range that existed for much of August, we believe that it may remain range-bound but with wider bands as we head into the autumn months unless we get confirmation that lingering headlines are dissipating or more macro data weakens along with what we have seen with manufacturing.

Regardless of market direction, we also do not expect to see lasting rotations away from market leadership, such as large-cap, growth and quality stocks toward out of favor areas. However, we do believe that investors may want to look harder at diversification tools, such as gold mining stocks or gold bullion to bolster their portfolios.

(The views expressed here are those of the authors and do not necessarily reflect those of ETF Strategy.)